Limited Liability Exists For A Reason

The reporting around the Pike River Coal compensation, which allegedly can’t be paid because the firm has minimal assets after paying for legal expenses, has been light on discussion of why limited liability exists.

There is a trade off between limited liability and unlimited liability. If you really think that the directors and shareholders of this firm should “reach into their own pockets” to cover the compensation awards imposed, you need to realise the wider consequences of such a demand.

But they are unwilling to include any discussion of what “limited liability” means and the consequences for entrepreneurial activity if the corporate veil is pierced everytime there are broken hearts involved, is disappointing.

Limited liability exists so shareholders can only lose the value of their investment. It encourages economic activity, because when unlimited liability is the case, there are a whole lot of perverse incentives created, including the ability to chase down one shareholder to pay for the company’s mistakes because of joint-and-several liability.

The collapse of the City Of Glasgow Bank, where shareholders liability was unlimited, is a sorry tale of what happens when shareholders are required to pay for the mistakes of directors and executives. It isn’t smart policy because a lot of socially beneficial risk taking would not occur in an unlimited liability environment.

In the case of the Pike River Coal mine, and the requirement that the firm pay compensation to the 29 victims, is stripping away the concept of limited liability really necessary in this case? The offer of $5,580 per victim – while it might seem like much – seems to be calculated to leave the company with nil assets.

It might seem mean and just another indication of big, bad capitalists getting away with something, but it’s nothing of the sort. Limited liability exists for a reason, and after the trouble the families of the victims had to go to in order to even get this award, is a stark reminder that we have to take responsibility for our own financial situation because we never know when disaster could strike.